Advanced Micro Devices (AMD - Free Report) shares are shaping up to be one of the top gainers this year with a year-to-date return of over 210%.
Most of this success story is based on its rivalry with Intel (INTC - Free Report) , a company it seems to be beating with its new product lineup not only in the desktop but also in the server segment (that Intel has dominated for long) and mobile.
The truth is, Intel’s yield issues and consequent squandering of its process lead have opened the door to increased competition, particularly for AMD (the other x86 player that has seen a bout of increased innovation at around the same time). Moreover, the vacant CEO position is not helping things at Intel.
Intel’s former CEO said that the company was trying to contain server market share loss to AMD at under 15-20%. AMD CEO Lisa Su has said on earnings calls that the company is targeting mid-single-digit server unit share by the end of 2018 on the strength of its EPYC family. AMD counts Cisco (CSCO - Free Report) AND Hewlett Packard Enterprise (HPE - Free Report) as customers.
The company is even more optimistic about the desktop market where it is targeting 20% market share this year and 40% in 2019, driven by its Ryzen chips.
Market share is a function of not just the technology but also the process. AMD is splitting production between Globalfoundries and Taiwan Semiconductor TSMC for the 7nm designs.
Su has expressed satisfaction about the foundries’ ability to deliver the volumes required to pick up additional market share. But the decision to move over some production to TSMC, which is further along with the transition to smaller geometries could mean that Globalfoundries is lagging behind (the company has changed CEOs a number of times in the last few months). It could also mean that the company is simply preparing for higher volumes.
Whatever be the case, if successful, the increased volumes will greatly boost profitability at AMD, since the newer products will have higher ASPs and therefore generate higher margins.
AMD also battles NVIDIA (NVDA - Free Report) in discrete graphics where it gained significant market share in the first quarter before relinquishing those gains in the second as some price competition played out, according to Jon Peddie Research. Both companies have new products lined up for the fourth quarter build season and there’s nothing to suggest any deterioration in AMD’s market share of around 30% (NVIDIA owns the rest of the market).
Semiconductor product cycles are long, so AMD is likely to hold its gains in the near to midterm and Intel will have to try really hard to contain it if it can. This is likely why analyst estimates for AMD are soaring. The following chart shows that the earnings estimate for the current fiscal year is up 63.6% over the past year-
This looks more than priced-in, however-
AMD’s PEG of 4.51X is high, both with respect to the historical period when it has varied between 7.43X and 3.35X with a median value of 4.40X and the S&P 500 PEG of 1.78X.
It also isn’t attractive on the basis of sales. The current P/S (TTM) of 5.72X recently shot past the S&P 500’s 3.48X and is close to its 6-month high of 5.86X.
AMD might have a lot going for it, but the rich valuation keeps us from the name. The shares therefore have a Zacks Rank #3 (Hold). For smarter picks, see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
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